Laying inflation at government's door

ByDavid R. FrancisJanuary 3, 1980

Boston
— "There ain't no excuses for inflation." That, in effect, is what Alan Reynolds, an economist with the First National Bank of Chicago, maintains.

Apologists within or without the Carter administration try to explain away today's 13 percent rate of inflation by noting a variety of events supposedly beyond the government's control. They cite rising farm prices, jumps in interest rates, or OPEC-induced oil price increases as special "shocks" to the nation's price structure. They say the "underlying rate" of inflation remains much lower.

But, Mr. Reynolds told the Monitor, today's high rate of inflation cannot be excused away. "We just blew it.The government got kind of complacent. It monetized a lot of debt."

In an article in his bank's latest World Report, Mr. Reynolds recalls an embarrassing list of quotations from administration or congressional economists between 1975 and 1978 playing down the danger of inflation and urging faster growth of reduce unemployment.

For instance, in January 1978 the chairman of the Council of Economic Advisers, Charles Schultze, in testimony to the Joint Economic Committee, defended the administration's plans for continued budget deficits. "We recognize fully," he said, "that deficits on the federal budget do cause inflation if they create excess demands. We see no danger of that during the next two years, since unemployment is still high and there is ample slack capacity in the manufacturing sector to permit further increases in real output without encountering bottlenecks."

The next month the Congressional Budget Office held that a tight budget would bring inflation down only from 6 percent in 1979 to 5.1 percent in four years. But the nation would have "to settle for a low rate of economic growth (about 4 percent a year) and very slow declines in unemployment." On the other hand, if Congress stepped up spending by another $70 billion a year, real growth would average about 5 percent a year and inflation would eventually end up less than 1 percent higher.

Well, the optimism of these advisers proved unfounded. The recession of 1973 - 75 had brought inflation down to less than 5 percent by 1975. Real growth had picked up to 6 percent. But rather than being patient, the Carter administration and Congress prodded the economy with huge deficits.

In turn, the Federal Reserve System financed a sizable chunk of the resulting new Treasury debt. In three years, ending in the last quarter of 1978, the Fed's stock of federal debt increased by $26 billion, or 30 percent.

Growth of the nation's money supply accelerated. So eventually did inflation.

Mr. Reynolds does not buy most of the arguments of the administration economists or others that special circumstances account for the failure of their low-inflation forecasts.

"The idea that rising food prices are in some sense a unique and independent cause of inflation is particularly weak," he says. "Food prices are very sensitive to excess demand, and always rise sharply in every inflation (and then fall, leaving farmers with inflated costs)."

Looking at energy prices, Mr. Reynolds charges that price controls on oil and natural gas have encouraged demand and discouraged exploration for domestic supplies. The Energy Department's "entitlements program" requires refiners with above-average supplies of domestic price-controlled oil literally to subsidize the purchase of imported crude by other refiners. "That has made it easier for OPEC to get a higher price," he says.

Moreover, the loose fiscal and monetary policies in the United States have reduced the value of the dollar in terms of goods, like oil, and in terms of other currencies. It made it cheaper for strong- currency countries, such as West Germany or Switzerland, to buy oil at its dollar price. Mr. Reynolds also speculates that the declining value of the dollar has encouraged the hoarding of oil, either in the ground or above, much as it inspires hoarding of coins, gold, real estate, antiques, and other tangible assets.

Objecting to suggestions that the Federal Reserve Board should "accommodate" the increase in oil prices by a more generous credit policy, he says: 'In practice, any effort to pay US oil bills by printing more dollars is just a proven method of sinking the dollar and raising the dollar price of imported oil."

Mr. Reynolds does admit that the consumer price index exaggerates the rate of inflation by perhaps 2 percent by accounting for higher mortgage interest rates. Most homeowners, he notes, have fixed interest-rate mortgages. Only families buying a new home must fork out the extra payments. But inflation still would be running around 10 percent. Further, high interest rates are basically a result of inflation -- not its cause.

"Of course you can get inflation down," he says. "But it is painful." It will require long-term government fiscal and monetary discipline.